Will The CFTC Kill The End User Exemption?

When Capitol Hill set out to force derivatives onto exchanges, lawmakers carved out a broad exemption for so-called "end users" — non-financial companies seeking to hedge their exposure to fluctuations in currencies, commitments and interest rates. An ambiguity in the Dodd-Frank financial reforms, however, threatens to undermine the end-user exemption.

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The issue is whether the U.S. Commodity Futures Trading Commission (CFTC) can impose margin requirements on end-users. The Senate version of financial reform specifically exempted end-users. This exemption was lost on the version that emerged from the House-Senate conference, allegedly because it was redundant to provisions that more broadly carved out end-users from the requirements that derivatives trade on exchanges and pass through clearinghouses.

Recently, however, concern has arisen that the lack of an explicit exemption could give regulators the authority to impose margin requirements on end-users even though their swaps aren't traded on exchanges or cleared through clearing houses.

In short, the CFTC could effectively kill the end-user exemption.

To back up a bit, derivatives that must pass through clearing houses will be subject to margin requirements. Financial companies buying or selling swaps will be required to put up a certain percentage of their capital to provide a cushion for the clearinghouse in the case they fail.

Congress clearly intended to exempt end-users from this requirement. It carved out end-users from the mandate to trade through clearinghouses. Both Sen. Chris Dodd and Rep. Barney Frank signaled that they were not intending to impose margin requirements on non-financial companies.

But this did not resolve the question. Dodd-Frank grants broad authority to regulators to impose new rules on financial markets. At a meeting last month, CFTC chair Gary Gensler indicated that he believes the law grants the authority to impose margin requirements on end-user transactions.

This doesn't mean the CFTC will impose margin requirements on end users. In fact, they probably will not do so in the face of clear legislative intent. But the very fact that regulators believe they can has corporate America worried.

The ambiguity over an end-user margin requirements may already be hurting the economy. Companies concerned their swaps may be subject to government-mandated margin requirements are already setting aside capital. In effect, the ambiguity is creating a de facto margin requirement.

This has serious consequences for the real economy. Funds set aside for margin requirements, even margin requirements that haven't actually been imposed, are funds that cant be used for business investment or creating jobs. In short, it's another instance of uncertainty holding back an economic recovery.